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Why Teva Pharmaceutical Is Up 20% in 2018 So Far

Find out how the struggling generic drugmaker outperformed the market this year.

Teva Pharmaceutical Industries(NYSE:TEVA) borrowed a large amount of money to become the leading manufacturer of generic drugs -- just before the market for generic drugs collapsed. This forced the company to stop paying a dividend at the end of 2017. If that wasn't enough to send investors running for the hills to begin 2018, a branded treatment responsible for 17% of the company's total revenue last year has been losing ground to generic competition.

Although Teva looks like more trouble than it's worth on the surface, the stock is up 19.4% in 2018. Here are four key reasons investors aren't as afraid as you might expect.

Image source: Getty Images.

1. Manageable Copaxone losses

Not long ago, Teva relied on its multiple sclerosis treatment Copaxone for one-fifth of its total revenue, but sales haven't fallen quite as hard as feared. Mylan launched a generic version last October that was expected to hammer sales of Teva's branded version into the dirt, but it looks like steep discounts have helped Teva retain a significant share of the market. Compared to the previous-year period, North American Copaxone sales fell 43% during the first nine months of 2018, which is exactly how far Copaxone sales fell during the three months ended September.

Cheaper generic versions of Copaxone began flooding European markets last year, but you wouldn't know it by looking at Teva's recent results. During the first nine months of 2018, European Copaxone sales slipped just 5%, to $417 million.

Teva probably will need to cut branded Copaxone prices even further to maintain its share of the market. Now that the company leans on the treatment for just 13% of total sales, though, it looks like a slow-moving headwind that the company can eventually overcome.

Image source: Getty Images.

2. Generic prices finally near a bottom

The average consumer might not realize it, but average prices that generic-drug manufacturers receive for their products have collapsed in recent years. That's because five years ago, America's largest purchasers of generic drugs began teaming up to demand lower prices from manufacturers. Specifically, Cardinal Health, AmerisourceBergen, and McKesson aligned with CVS Health, Walgreens Boots Alliance, and WalMart, respectively. Express Scripts, which operates the third-largest U.S. pharmacy, also formed a group-purchasing organization for generics that brought Kroger and SuperValu into the fold.

According to Drug Channels, these four organizations accounted for 90% of U.S. generic-drug sales from manufacturers in 2017. Although Teva can't avoid dancing around the negotiating table with these behemoths, the purchasing organizations don't have any room left to grow.

With a bottom to generic prices in sight, a couple of investment bank analysts recently upgraded Teva. Although revenue from the company's North American generic segment isn't expected to surge over the next several years, it should at least stabilize. This looks like another manageable headwind now that the segment is responsible for just 20% of Teva's top line.

3. Cost cuts are working

Teva's workforce cutbacks haven't won management any popularity contests, but they are helping the company pay off huge debts. Management expects to achieve $3 billion in operating-expense reductions by the end of 2019, which encouraged the company to raise this year's free cash flow projection 11% higher, to a range between $3.6 billion and $3.8 billion.

Although Teva reported a $273 million net loss in the third quarter due to some non-cash charges, its profitable operations have what it takes to reduce the company's debt pile to a manageable level quickly. Since reaching a peak in late 2016, Teva has reduced total long-term debt by 25%, to $29.5 billion at the end of September.

Image source: Getty Images.

4. Blockbuster new drug launch underway

In September, Teva's next-generation migraine-prevention treatment Ajovy earned approval by the Food and Drug Administration (FDA). Eli Lilly and Amgen already have launched similar treatments in the U.S. and they're offering deep discounts right now to gain a leading share of a market that could be huge.

An estimated 36 million people in the United States suffer from migraines, and perhaps 40% would benefit from preventative treatment with Ajovy. Although competition will be fierce, peak annual sales are expected to top out above $1 billion.

More gains ahead?

Despite Teva Pharmaceutical's run-up this year, the stock still looks like a bargain at recent prices. Shares have been trading at just 7.7 times forward earnings expectations.

While this stock probably won't thrill investors with double-digit sales growth any time in the foreseeable future, it doesn't need to. At these low prices, modest growth over the long run is all Teva shares need to outperform.